Demonetisation: Lending rate cut hopes fade on RBI's 100% CRR shock

With withdrawals limited and deposits soaring since November 16, a week after the announcement of demonetisation, banks have been parking a record amount of money with the RBI through the reverse repo window.Partha Sinha | TNN | November 29, 2016, 08:21 IST

File photoMUMBAI: If you were expecting a sharp reduction in your EMI since banks are flush with funds because of demonetisation, you will have to wait a bit longer. Forget about an immediate rate cut, some banks may even be forced to hike rates, thanks to RBI's surprise move on Saturday to increase CRR to 100%. In fact, banks are expected to cut deposit rates sharply.

With withdrawals limited and deposits soaring since November 16, a week after the announcement of demonetisation, banks have been parking a record amount of money with the RBI at an average of 6.22% rate through the reverse repo window. Reverse repo is a facility provided by the regulator to allow banks to deposit excess funds for which they earn interest. A large chunk of this extra liquidity is parked in reverse repo of 20 days or more (up to 91days), which the banks will not be able to withdraw. A hike in cost of funds impacts lending rates as these are directly linked under the new formula prescribed by the RBI.

After the 100% CRR move for incremental deposits since September 16, banks will now borrow from RBI's repo window and pay the central bank at 6.26%. On Monday , banks borrowed Rs 6 lakh crore from the RBI, an all-time high amount. In the process, banks will lose 4 basis points (6.26% they will pay in the repo window while they'll get 6.22% through the reverse repo window) for a large chunk of their deposits.

To add to this loss, banks also have to pay their depositors at least 4% rate in savings bank accounts. So the total loss is at least 4.04% on these huge incremental deposits. “To contain further losses, at a time when demand for loans is low, there is no way banks will cut lending rates in the immediate future,“ said a top fund manager. In addition, banks will also need to provision for their bad loans, something that they have been resorting to for the past several quarters, said a bond dealer.

As the RBI squeezed out liquidity through CRR, government bond yields and also overnight call rates shot up on Monday . The benchmark 10-year yield hardened to 6.38% in early trades from its Friday close at 6.21%, while call rates, according to a Reuters report, had shot up to as high as 14.4% from Friday's average of 5.98%.

A report from SBI pointed out that because of the RBI decision, total CRR requirement of the banks would be around Rs 8 lakh crore. “Also, banks will have to resort to selling of government securities under repo operations in order to manage their liquidity position. This in turn could lead to rise in the yield of government papers,“ the report said.

Another report from India Ratings said that after RBI's CRR move, market's expectation of a rate cut in the upcoming monetary policy review could also face a downward revision, further weighing down on the bond market. “This could lead to the widening of spreads between Gsecs and corporate bonds, as near-term investor appetite will remain weak,“ Bansi Madhavani and Soumyajit Niyogi said in the report.

Faced with huge losses from various fronts, banks will ask for compensation, but the RBI is unlikely to be comfortable with such a demand, said a report from Deutsche Bank. “The expected gains for banks (from deluge of deposits post demonetisation) could turn out to be a net loss for them...the immediate reaction of banks would be to cut deposit rates, especially retail term deposit sharply -maybe by 50-100 basis points,“ the report by Manish Karwa and Manish Shukla said.